Sliding dollar is the new painkiller for global markets
Ever since the 2008 financial crisis, the ultra-loose monetary policies of the world’s main central banks have acted as a painkiller, helping stabilise markets and providing a fix for investors and traders desperately searching for higher-yielding opportunities at a time of historically low – and in some cases negative – interest rates.
While money is still cheap, with the Bank of Japan and the European Central Bank yet to call time on their aggressive quantitative easing programmes and the Federal Reserve raising interest rates at a gradual pace, a new source of relief has grown in importance over the past year: the sliding US dollar.
A year ago, the overwhelming consensus in markets was that the greenback would continue to strengthen following the election of Donald Trump as US president, whose pro-growth policies were expected to boost growth and inflation. Yet as the so-called “Trump trade” quickly unravelled, the dollar index – a gauge of the greenback’s performance against a basket of its peers – tumbled, falling 10 per cent last year, its worst year since 2003.
The weaker dollar has been a major factor behind the loosening of financial conditions, along with the surge in global equities, the dramatic tightening of spreads on corporate debt and, until recently, the decline in government bond yields.
The greenback’s retreat, and the build-up of speculative bets against the dollar, is turbocharging a rally that was given added impetus by a series of bullish surveys last week pointing to the strongest synchronised global economic upturn since 2010.
The weaker dollar’s impact on asset prices and market expectations is most pronounced in the following areas:
Commodity prices surge – the Bloomberg Commodity Index, a gauge of the performance of 22 raw materials, has shot up more than 4.5 per cent since mid-December and has just enjoyed its longest stretch of daily gains on record. The surge in the index has been driven by the sharp rise in oil prices, with Brent Crude, the international benchmark, up almost 50 per cent since late June to its highest level in over three years.
The dollar’s slide, which makes commodities cheaper in other currencies, has also helped drive up the price of palladium, currently close to an all-time high, and copper, which are benefiting from robust growth in manufacturing activity.
Emerging markets on a roll – the weaker greenback has proved a boon for developing economies too. The MSCI Emerging Markets Currency Index is now trading at its highest level since the so-called “taper tantrum” in May 2013 when the Fed triggered a sharp sell-off by unexpectedly announcing that it would begin scaling back its asset purchases. Emerging market equities surged more than 30 per cent last year and gained a further 3.7 per cent last week.
Monetary tightening could be delayed – The flip side of a weaker dollar – the appreciation of other currencies, notably the euro which has gained more than 13 per cent since last April – may end up postponing the tightening of monetary policy in other parts of the world. If the euro keeps rising, inflation and growth in Europe could slow, making the ECB even more reluctant to withdraw stimulus. Make no mistake, a further decline in the dollar could keep global monetary policy looser for longer.
Yet just as investors were caught unawares by the dollar’s steep fall in 2017, their bets that the greenback will continue to slide this year may backfire.
Hedge funds believe the bearish dollar trade is overdone. Their positions even turned net positive last month for the first time since June, according to data from Bloomberg. Stronger growth and inflation in the US – a more likely prospect following last week’s robust manufacturing data – could force the Fed to raise interest rates more aggressively than markets anticipate.
If the Fed managed to increase rates three times last year when inflation remained subdued, then what is stopping the US central bank raising them four times this year – markets expect only two increases in 2018 – if consumer prices pick up significantly?
Still, the fact that three rate increases and a sharp rise in yields on short-term Treasury bonds failed to provide any support to the greenback is reason enough for dollar bears to remain sanguine.
More importantly, despite its tumble last year, the dollar index still remains 15 per cent higher than its level in mid-2014.
A bit more stimulus from a still-overvalued dollar is no bad thing.
Nicholas Spiro is a partner at Lauressa Advisory